Prediction: The next five years will see at least five more major collapses of UK law firms.
You don’t have to look back far to see the impact of the current tough financial market conditions on law firms. Halliwells, Cobbetts, and most recently Challinors all fell foul of the impact of poor decisions, exacerbated by the dearth of demand for legal services.
Similarly, it is probable that the market won’t have to wait long before it sees the next major law firm collapse.
“We agree that there will be a handful of high-profile failures dominated by highly leveraged firms focusing predominantly on the UK market and with limited differentiation from their peers,” says Tom Wood, head of professional services industry at Barclays. “We also expect a continuation of the trend of mid-market consolidation, including a number of distressed mergers.”
“While I would not bet against it I think we will see many more firms suffer death by a thousand cuts,” agrees Burness Paull chairman Philip Rodney. “Weaker firms may be forced to compete in markets they are not geared up for, with consequent reduced profitability.”
Kerma Partners consultant William Arthur describes a future that looks even more dystopian than the one Wood envisages.
“At least five firms will have gone spectacularly bust,” says Arthur, bluntly looking forward to 2018. “They will have run out of cash
because a major creditor has
Arthur believes that access to funding will be a major challenge for many firms for a variety of reasons including the need to invest heavily to increase competitive capability and/or access new markets; the pockets of partners not being deep enough (or willing enough) to fund this investment; and lenders, despite being ‘open for business’, being increasingly choosy about who they will fund, and how much they will lend.
“This is partly due to pressure on their own balance sheets from tightening regulation, and partly due to a more bearish attitude to a sector, previously regarded as risk-free, that can deliver some stinging losses,” he adds.
“New entrants will tend to be better and/or more appropriately funded, giving them operational flexibility and competitive advantage. Bank debt levels of firms, in proportion to fees, will be lower because lenders are more demanding and firms will have recapitalised, seeking greater contributions from partners, assuming that capacity exists, or from external investors.”
Gloomy though these projections may be, there is a flipside, particularly for those firms that have a handle on the operational side of things. Certainly, senior support professionals in areas such as IT, business development, HR and finance now have a seat at the top table when it comes to big operational matters and strategy. An influx of external talent may help protect firms from the axeman.
“The big winners in the future will be the most progressive ones who run their business as just that – a business,” argues Elliot Moss, director of business development at Mishcon de Reya. “This means the full integration of finance, people development and marketing into the firm’s management and strategy.”
It also probably means avoiding going too far into the red.
Prediction: Debt levels will continue to grow and sources of funding will diversify.
“Funding for firms as we know it will change,” says Barclays’ Wood. “We expect a reduction in on-demand, on-balance sheet debt, to be replaced by more strategic funding lines linked to growth plans, such as committed revolving credit facilities. We also expect to see off-balance sheet funding to diversify, with firms moving away from partner capital and opting for a blended arrangement to include private equity, debt capital market lines and retained profits. This could be a stepping stone to a listing that would, in turn, provide an exit for the private equity provider.”
But as Kerma Partners’ William Arthur points out, the financial pressures are likely to force firms to be ever more efficient when it comes to cashflow.
“Lock-up will be reduced to an average of 100 days,” says Arthur. “This is the one key lever firms have left to pull and bank pressure may force it to happen.”
What will not change in the next five years are the risks of being too heavily leveraged. Firms’ attitude to that risk, however, must change.
“Firms must look at risk through a new lens,” says Louise Fleming, executive director at consultancy Kingsmead Square. “We need to embed an enterprise-wide view. Risk is the responsibility of management. In the next five years enterprise-wide risk management will become accepted and expected.”
Prediction: At least one major firm will be brought down by a cyber security leak.
Five years on from Lehman it is not only regulation of financial institutions that is being overhauled, regulators are turning their attention to IT too.
“By 2018 there’ll be a framework set by regulators as to what data law firms can and can’t put into the cloud,” says Kemp Little founder Richard Kemp. “There will be more shared environments between clients and firms through cloud access. Tension will grow between the flexibility IT brings and regulatory intrusiveness.”
There will also be a new world of opportunities created by the threat of cyber security. Baker & McKenzie is among the international firms building a cross-border team to handle issues such as class action consumer litigation and privacy issues, regulatory matters, crisis management and client image.
“This reaches right up to the C suite,” says the firm’s chairman Eduardo Leite. “It’s very valuable.”
Leite recalls hearing an FBI agent at a recent conference.
“He said there are two kinds of companies regarding cyber security,” says Leite, “those who know they were hacked and those who don’t. The law firms are not the target, it’s the clients.”
David Morley, Allen & Overy